debt
Banking Terms -> debt
- Debt is a term used for money that is owed, but it can refer to various transactions and obligations, which do not involve money. In the world of financial transactions, debt is understood as using future income at present, before money was actually earned. Debt is being created when a borrower receives certain sum of money from a creditor. Creditors extend loans and expect full repayment, including interest. Before debt is created, the creditor and debtor should agree on how the debt will be paid back. The payment typically represents an amount of money in some currency but in some cases, the debt amount may be denominated in terms of services and goods. Depending on the loan agreement, the payment can be made as a lump sum at the loan’s term or in increments within a specified period of time.
In terms of benefits, debt makes it possible to buy different products and services, invest, and do things that would be otherwise not possible to do. Persons in the developed nations use borrowed money to buy real estate property, cars, and other big-ticket items that are too costly to buy using only one’s savings. Businesses, on the other hand, use borrowed money to expand, to finance new projects, etc. Debt increases with time if interest grows faster than the rate of repayment. The term usury is used for excessive interest rate which is higher than the profit for the risk one has accepted.
Debt can be in the form of bonds, loan note, mortgage, and any other type of debt, which has interest requirements and repayment terms. These types of debt are repaid over a specified period of time, which will be set forth in the loan agreement. Debt can be unsecured and secured, and collateral is required with the second type. Credit card debt is another type of debt, which comes in the form of line of credit. Credit cards are of different varieties, including no fee credit cards, cash back credit cards, rewards credit cards, etc. In addition, they can be subdivided into business and personal credit cards.
Businesses often need fresh financing, which cannot be secured by using a credit card only. With debt financing, entrepreneurs who seek money for their business should evaluate the company’s debt-to-equity ratio. This term refers to the relationship between the amount of money borrowed and what is invested in business operations. The larger amount of money has been invested in the company, the easier it becomes to attract more financing. Debt financing generally refers to borrowing over a set period of time, which is different from equity financing. In the case of debt financing, ownership in a business is not required.
There are different sources of debt financing, including finance companies, credit unions, banks, the U.S. Small Business Administration, and others. Smaller loans can be given out by friends and family as well.
The main method through which banking institutions lend money is called cash credit. It works like a current account, but the money that one withdraws is not limited to the funds deposited into it. In principle, cash credit is payable on demand. Another term associated with debt is bank overdraft. Overdraft implies overdrawing from one’s account. Put simple, the holder of the account withdraws more money that he has previously deposited. Overdrafts occur when the available balance is less that the withdrawal. This results in a negative balance. If there is an overdraft protection plan, and the overdrawn amount is within the limit of the authorized overdraft, the bank will usually charge at the agreed rate. However, when the balance exceeds what was agreed, higher interest may apply.
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